Accrual Accounting –

Definition:
Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned or incurred, rather than when cash is received or paid. This approach follows the matching principle, which aims to match revenues with the expenses incurred to generate those revenues within the same accounting period.

Key Features:

• Revenue Recognition: Income is recorded when a sale is made or a service is performed, not when payment is received.
• Expense Recognition: Costs are recorded when they are incurred, not when they are paid.
• Matching Principle: Ensures that income and related expenses are reported in the same period, giving a more accurate picture of profitability.

Example:

Suppose a company provides consulting services in December but doesn’t get paid until January. Under accrual accounting:

• The revenue is recorded in December (when the service was performed).
• Any expenses incurred in providing the service (e.g., contractor fees) are also recorded in December.

Benefits:

• More Accurate Financial Picture: Reflects true financial performance over time.
• Better for Long-Term Planning: Useful for businesses with credit transactions or complex operations.
• Required by GAAP/IFRS: Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) mandate accrual accounting for most larger businesses.

Comparison: Accrual vs. Cash Accounting

Who Uses Accrual Accounting?

• Corporations
• Publicly traded companies
• Businesses with inventory
• Companies with long-term projects or credit sales